Non Performing Assets (NPA) - Meaning, Example, Different Types, Working and Its Impact

NPA is an abbreviation for Non-performing Assets, which are loans issued by Indian banks and other functioning financial institutions that have accumulated interest and principal over a long period of time. Non-Performing Assets, or NPAs, are an unwelcome phenomenon in India’s banking industry. This is analogous to cancer, which is destroying India’s whole banking sector.

The NPA is significant for the UPSC Prelims and GS Paper 3 of the UPSC Mains curriculum. In this article, we will provide you with all the features and necessary information on the Non-performing assets. Study major topics of Economy from the perspective of UPSC Exams.

Recent Update

• As of March 2022, banks’ Gross Non-Performing Assets (GNPAs) have declined to a six-year low of 5.9% (7.4% 2021).
• According to CareEdge research, India’s NPA ratio is among the highest among comparable countries. Russia’s bad loan rate is 8.3%.
  • China’s NPA ratio is 1.8%.
  • The ratio in Indonesia is 2.6%.
  • South Africa’s ratio is 5.2%.
• NPAs are fewer than 3% in the majority of developed economies.

What is a Non-Performing Asset?

A nonperforming asset (NPA) refers to a debt where the borrower has failed to make the agreed interest and principal payments to the lender for an extended duration, resulting in the NPA not generating any income for the lender in the form of interest payments.

Examples of NPA

• Kingfisher Airlines (KFA) Ltd. Case: A lesson from Vijay Mallya's ambitious venture that led to ₹6,900 crore in loans from 17 banks, making KFA a non-performing asset.
• Firestar International Pvt Ltd. Case: Nirav Modi's company, Firestar International, utilized fake LOUs to secure loans from banks, resulting in ₹12,700 crore in non-performing assets.

Technical Definition of Non-Performing Asset Given By RBI

• The RBI declared in a circular released in 2007 that “an asset becomes non-performing when it fails to produce income for the bank.”
• A non-performing asset (NPA) is more than 90 days past due on a loan or advance. This means that any defaulted or arrears loans or advances will be categorised as non-performing assets (NPA).

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Various Types of Non-Performing Assets

• Term loans are the most typical non-performing asset kind, although there are other kinds.
• Accounts with an overdraft or cash credit that have been inactive for longer than 90 days.
• Agricultural loans whose principal instalment payments have been past due for two harvest or crop seasons or one crop season, in the case of long-term crops.
• Any account with an expected payment is more than 90 days past due.
• A bank’s balance sheet suffers when loans and advances are not returned within the agreed-upon time frame. NPAs put the lender under financial strain.
• Usually, a grace period is given by lenders before designating an asset as non-performing. The lender or bank will next classify the NPA into one of the below sub-categories:

Standard Assets

They are NPAs with a normal risk rating that have been past due for 90 days to 12 months.

Sub-Standard Assets

They are non-performing assets (NPAs) with over a year of past due balances. When partnered with a borrower that has less than excellent credit, they are more riskier. Because they are less convinced that the borrower will return the total amount, banks often take a haircut on such NPAs.

Doubtful Debts

The questionable debts category includes non-performing assets at least 18 months past due. Banks frequently have doubts about the borrower’s ability to repay the whole amount. This kind of NPA significantly impacts the risk profile of the bank.

Loss Assets

These are non-performing assets that have accumulated a significant amount of outstanding debt. Banks must anticipate that the loan will never be repaid and, as a result, must record a loss on their balance sheet. The whole loan balance must be canceled.

Working of Non-Performing Assets (NPA)

• After a period of protracted delinquency, the lender requires the borrower to liquidate the assets pledged as collateral in the loan arrangement.
• Loans are not transferred into the NPA category until a significant time of nonpayment has occurred.
• Lenders consider all the variables that may cause a borrower to be late on interest and principle payments and may prolong a grace period.
• Banks may foreclose on whatever property or asset was used to secure the loan to collect the outstanding debt.
• If no assets were pledged, the lender writes it off as bad debt and sells it at a loss to a collection agency.
• A loan can be categorised as a non-performing asset at any time throughout its term or at maturity.

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Reasons for NPAs in India

• Public sector banks give a large share of credit to industries, and it is this element of credit distribution that accounts for a large portion of NPA.
• In Kingfisher Airlines’ financial difficulties, SBI issued a large loan from which it could not recoup.
• Before the 2008 financial crisis, India’s economy was booming. During this time, banks extended large amounts of credit to corporations in the hope that the good times would continue in the future. However, the future does not necessarily follow the same pattern as the past.
• Low incomes could have improved their capacity to repay debts. This is one of the primary reasons for the rise in NPAs at public sector banks.
• Another key contributor to increased NPAs was the loosening of corporate lending standards. Their financial situation and credit rating should have been thoroughly examined.
• The priority lending (PSL) sector has significantly contributed to the NPAs.
• Agriculture, education, housing, and MSMEs are among the priority sectors. According to SBI estimates, school loans account for 20% of NPAs.

Wilful Defaulter

• Credit default by promoters has occurred when funds were transferred by over-invoicing imports supplied through a promoter controlled company overseas or exporting to shell businesses and then announcing that they defaulted.

GST Impact on Banking NPA

• The impact of GST on banks and NBFCs would be so significant that operations, transactions, accounting, and compliance will have to be completely rethought.
• They must get separate registration for each state they operate under GST. In terms of regularity and the number of returns, the compliance burden has also grown.

Payment Banks impact on the Indian banking system.

• Payment banks will intensify competition in the banking business. The entrance of new businesses from diverse industries setting up these payment banks, bringing their marketing concepts and different clients on board, would exacerbate the competition for customers in an already congested banking industry.

Impact of NPA on Economy

• Rising NPAs damage the bank’s reputation, causing the public to lose faith in banks. Depositors may withdraw their funds, forcing banks to run out of liquidity.
• Banks need more liquidity to lend for other productive activities in the economy.
• The reduction in investment may cause the economy to stall, resulting in unemployment, inflation, a bear market, and so on.
• Banks must raise interest rates to retain their profit margins, harming the economy.

Impact Of NPAs on Banks

• Increasing NPAs not only impair banks’ earnings but also undermine their reputation. In reality, the enormous volume of NPAs with commercial banks threatens to destroy half of public sector banks’ capital base.
• If a bank begins to experience losses and the fundamentals are not remedied, the problem may grow chronic and erode depositor confidence.

Impact of NPAs on Industry

• During the years 2006-11, credit growth to the industrial sector was larger than GDP growth and credit growth. As a result, the share of NPAs in the industrial sector was significantly greater than in other sectors.
• As a result, in the later stages, banks needed to be more open to support the demands of the industrial sector, stifling its expansion.
• In reality, credit has shrunk in some areas, such as the Micro, Small, and Medium Enterprises (MSME) market.

Impact on Infrastructure

• The infrastructure accounted for the biggest chunk of NPAs, and the banks are now reluctant to fund this sector.
• As infrastructure is one of the most important sectors in the economy, which fuels the growth of other sectors, draining resources to infrastructure may hamper the growth of the Indian economy.

Measures to Tackle NPA

The below mentioned are the measures taken tackle NPA:

The Debt Recovery Tribunals (DRTs) – 1993

The Recovery of Debts and Bankruptcy Act (RDB Act) 1993 establishes Debts Recovery Tribunals (DRTs). DRTs are constituted for debt recovery, insolvency resolution, and individual bankruptcy, among other things.

Credit Information Bureau – 2000

Credit Information Bureau (India) Limited was the previous name for TransUnion CIBIL Limited. It is India’s first Credit Information Company, founded in 2000. It gathers and stores credit-related information from individuals and businesses, such as loans and credit cards.

Lok Adalats – 2001

Lok Adalat institutions assist banks in resolving disputes involving accounts classified as “doubtful” or “loss,” with an outstanding balance of Rs. 5 lakh for compromise settlement under Lok Adalat.

Compromise Settlement – 2001

A compromise settlement is a negotiated settlement in which a borrower proposes to pay, and the bank agrees to accept as a complete and final settlement of its dues a sum less than the entire amount due to the bank under the relevant loan contract.

SARFAESI Act – 2002

The SARFAESI Act of 2002 has two basic goals: recovering non-performing assets (NPAs) from financial institutions and banks in a timely and effective way. If a borrower defaults on his or her obligation, it authorises financial institutions and banks to sell residential and commercial assets at auction.

ARC (Asset Reconstruction Companies)

An asset reconstruction business is a sort of financial firm that acquires a bank’s debtors at a mutually agreed-upon price and seeks to collect the debts or linked securities on its own. The ARCs assume a portion of the bank’s debts classified as Non-Performing Assets.

Corporate Debt Restructuring – 2005

The rearrangement of a distressed company’s existing commitments to its creditors is referred to as corporate debt restructuring.

The goal of a corporate debt restructuring is to restore a company’s liquidity so that it can avoid bankruptcy.

5:25 rule – 2014

The 5:25 strategy allows banks to make long-term loans of 20-25 years to match project cash flow while refinancing them every 5 or 7 years. This is anticipated to align financial flows with payback schedules, making long-term infrastructure investments sustainable.

Joint Lenders Forum – 2014

The Joint Lender’s Forum is a specialised organisation of lender banks designed to expedite decisions when an asset (loan) worth more than Rs 100 crore is discovered to be a stressed asset. In 2014, the RBI released recommendations for the creation of JLFs for the effective management of stressed assets.

Mission Indradhanush – 2015

The Mission Indradhanush for PSBs intends to reorganise public sector bank operations to compete with private sector banks. It aims to revitalise economic development by reducing political meddling in PSB operations and boosting lending.

Strategic debt restructuring (SDR) – 2015

The RBI’s Strategic Debt Restructuring Scheme, or SDR, allows banks that have made loans to corporations to convert a portion of the total outstanding loan amount and interest into substantial shareholder equity in the firm.

Asset Quality Review – 2015

A unique assessment known as the Asset Quality Review was conducted in 2015-16. (AQR). Asset quality rating evaluates the riskiness of assets in a portfolio. According to the RBI’s AQR, the examined banks had a higher level of asset quality deterioration or non performing assets (NPAs).

Sustainable structuring of stressed assets (S4A) – 2016

The S4A Scheme seeks to achieve a comprehensive financial restructuring of large debted enterprises by allowing lenders (banks) to purchase equity in the stressed project. The plan allows for the financial restructuring of big projects while also assisting lenders in dealing with stressed assets.

Insolvency and Bankruptcy code Act-2016

The Insolvency and Bankruptcy Code, 2016 (IBC), was adopted in response to rising non-performing debts. It intends to address non-performing assets by developing a centralized framework for insolvency resolution of companies, partnership partnerships, and individuals promptly.

Pubic ARC vs. Private ARC – 2017

This argument, which is now in the headlines, is about the proposal of a government-funded and administered Public Asset Reconstruction Companies (ARC).

The economic survey refers to it as PARA (Public Asset Rehabilitation Organization), and the proposal is based on the effectiveness of a comparable agency during the East Asian crisis 1997.

Bad Banks – 2017

A non-performing asset (NPA) is a banking industry term for a ‘bad loan,’ or one that has not been repaid within the time frame specified or when planned payments have fallen behind. The term “bad bank” can refer to any structure that allows for the separation of performing assets from non-performing assets, either on or off the balance sheet.

Recapitalisation of Banks

Recapitalization is the reorganisation of a company’s debt and equity ratio. The goal of recapitalization is to stabilise the capital structure of a corporation. The government should inject equity capital into public sector banks due to their weak balance sheets.

Prompt Corrective Action

The Prompt Corrective Action (PCA) approach is designed to nurse a lender back to health regarding asset quality, profitability, and capital. To prevent shocks from spreading across the financial system and to maintain financial stability, the Reserve Bank of India (RBI) employs PCA to intervene when a lender exhibits symptoms of distress.

Other Terms Related to NPAs

Write-off effect

A write-off is an accounting move that decreases the value of an asset while debiting a liabilities account at the same time.

Twin Balance Sheet

A twin balance sheet is a scenario in which banks are under severe stress, and corporations are overleveraged to the point of being unable to repay their debts. A twin balance sheet problem follows a predictable pattern. Their businesses grow during a boom, leaving them with debts they cannot repay.

Four Balance Sheet Challenge

The Four Balance Sheet Challenge comprises the initial two sectors, infrastructure businesses and banks, NBFCs, and real estate enterprises. India’s Four Balance Sheet Challenge originates from the Twin Balance Sheet Problem.

Significance of Non-Performing Assets

• Both borrowers and lenders need to understand the difference between performing and non-performing assets.
• For borrowers, having non-performing assets can harm their credit and future borrowing prospects due to missed interest payments.
• Lenders, such as banks, rely on interest income from loans, so non-performing assets can hinder their ability to generate income and overall profitability.
• Banks must monitor their non-performing assets because too many of them can impact liquidity and growth prospects negatively.
• The manageability of non-performing assets depends on their quantity and how overdue they are.
• While banks can handle some NPAs in the short term, a growing volume of NPAs over time can threaten their financial health and future success.

Conclusion

A non-performing asset (NPA) is a financial institution categorization for loans and advances on which the principle is past due and no interest payments have been paid for an extended period of time. It is vital to remember that if a borrower has numerous facilities with a bank and one of them becomes an NPA, then all of the bank’s facilities must be classified as NPAs, not just the one that has turned irregular.

In this article, we analyze the structure and terms of the NPA in India. To study more topics from the Indian Economy for UPSC, download the Testbook App now!